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Fiat and Commodity Backed Money

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Bitcoin doesn’t lean on a system of debts, its value boils down to how effective it is as a medium of exchange. The Royal Canadian Mint still issues Playing Card Money in commemoration of its history, but now in 92.5% silver form with gold plate on the edge. It therefore has an intrinsic value which considerably exceeds its fiat value. The Bank of Canada and Canadian economists often use this early form of paper currency to illustrate the true nature of money for Canadians.

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Furs and agricultural commodities such as maize were employed in trade transactions throughout the 17th and early 18th centuries. For example, during World War II, prisoners were using cigarettes as commodity money, and they were exchanging them for other goods and services. A cigarette’s value was attached to a certain portion of bread.

Which of the following best explains the difference between commodity money and fiat money? A….

Indian rupees, US dollar, British pound, and other currencies are examples of fiat money. Commodity money, on the other hand, includes items such as gold, silver, copper, tea, and so on. The quantity of gold coined in a commodity monetary system, such as the gold standard, is determined by market forces. The amount of gold sent to the mint for coinage and the number of gold coins melted for other purposes determine the number of gold coins required by the general population. As a result, the intelligence and understanding of all those who regulate the supply of money can be said to determine the value of commodity money.

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On the other hand, the government does not issue the commodity money and the value of the money. Even using Bitcoins as a means of payment can be problematic, since most people would want to look up the current exchange value before engaging in a transaction, thus complicating even simple transactions. Moreover, the value of Bitcoin could change significantly between the time that someone receives it as income and the time that it is spent, making financial planning impossible.

Main Differences Between Fiat Money and Commodity Money

Inflation does the most damage to money as a store of value, since its value continually declines as more money is created. Rather than keeping an inflating currency, people spend it as fast as possible before it loses value, which, in turn, causes prices to rise even more. Because fiat money is not linked to physical reserves, such as a national stockpile of gold or silver, it risks losing value due to inflation or even becoming worthless in the event ofhyperinflation. If people lose faith in a nation’s currency, the money will no longer hold value.

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Earlier in U.S. history, the country’s currency was backed by gold . The federal government stopped allowing citizens to exchange currency for government gold with the passage of the Emergency Banking Act of 1933. The gold standard, which backed U.S. currency with federal gold, ended completely in 1971 when the U.S. also stopped issuing gold to foreign governments in exchange for U.S. currency. The term “fiat” is a Latin word that is often translated as “it shall be” or “let it be done.” Thus fiat currencies only have value because the government maintains that value; there is no utility to fiat money in itself. One danger of fiat money is that governments can print too much of it, resulting in hyperinflation.

Thus, a politically stable country possibly has a strong fiat currency that facilitates purchasing power. Contrastingly, an unstable nation has weak money, hindering purchasing power. Value Tied to Government – one of the cons of fiat money is that the money will only have value for as long as the people believe and accept that it has value. The money has the government’s full faith and backing, no physical asset.

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This is why the people in early America accepted banknotes, because the bank stood ready to redeem their notes in specie, which were gold or silver coins. However, some banks issued more notes than they had specie; when the public found out, they would run to the bank with their banknotes to redeem them before the bank ran out. Such runs on the bank, as they were called, were a frequent occurrence in 18th and 19th century America, when many states did a poor job of monitoring the banks that they chartered. Eventually, starting in 1861, the federal government started issuing its own notes, that were backed by government bonds held at the United States Treasury. Fiat money is a type of currency that is not backed by a commodity, such as gold or silver.

What’s the difference between a cryptocurrency like Bitcoin and fiat money?

No records are kept of who owes what to whom, so there is only one way of exercising the claim, and that is to surrender the coin. If one melts the coin instead, the claim is gone, and so is the State’s liability. All that remains is a lump of metal whose material value obviously belongs to the bearer. Melting thus transforms a fiat vs commodity asset into a real asset from the bearer’s point of view.

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Many people are probably borrowing money by mortgaging their homes or taking cash advances on their credit cards to bet on this speculative bubble. However, if the price drops sharply, it will cause many people to exit at the same time, causing even greater price drops. Eventually, it will probably stabilize, then go up and down again — who knows for how many cycles — but the economy may be severely damaged if too many people borrowed money to bet on Bitcoin. If economies are damaged too severely, then governments will step in to regulate the cryptocurrencies.

Difference Between Fiat Money and Commodity Money

It must provide a means of transferring money from one party to another securely and keep a record of the transaction to prevent double spending, spending Bitcoins more than once by the same person. Transaction records must be secure from hacking so that they cannot be altered. Although commodity money is usable in some form other than as money, it also must satisfy the other characteristics of money.

Whereas the downsides of https://www.beaxy.com/ money include things like the abuse of bamboo trees for paper making, manufacturing instability at times, hyperinflation, excessive transaction costs, and so on. There is a great benefit to being able to manipulate the money supply, which is why the gold standard was abandoned by every country years ago. An economy needs a certain amount of money to function properly, to keep values steady. Although inflation decreases the value of money, inflation is kept steady by the central banks, so it is largely predictable. If the central banks did not have the ability to create or destroy money as needed, then the value of currency would fluctuate with economic conditions. Money, as well as its origins and value, are defined by economists.

Also, fiat vs commodity money makes a solid currency as it handles everything a nation needs to create monetary units. It holds value, is easy to exchange, and the currency is countable. Plus, it’s cost-efficient to produce the currency — known as seigniorage. Cryptocurrency is another fiat money alternative that’s on the rise.

What are examples of commodity money?

Examples of commodity money includes commodities such as gold, silver, copper.

A military expedition against the Iroquois had gone badly and tax revenues were down, reducing government money reserves. Typically, when short of funds, the government would simply delay paying merchants for purchases, but it was not safe to delay payment to soldiers due to the risk of mutiny. In monetary economics, fiat money is an intrinsically valueless object or record that is accepted widely as a means of payment.

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But now, instead of gold, we use currency such as the U.S. dollar, the euro, and even cryptocurrency in exchange for products. Physical commodities like gold or silver have a value attached to them, and we can redeem them by exchanging them through currencies. However, the currency has no backing concerning the physical commodity. That’s when the valuation of currency becomes essential in Fiat money.

Does Fiat Money Have Intrinsic Value?

No. Fiat money has no intrinsic value. Rather, it conveys a legal tender whose worth is fixed by the issuing government and the supply and demand relationship. Additionally, it is not supported by any physical commodity and is determined as per the administration’s stability.

Fiat money by contrast, has no intrinsic value – it is essentially a promise from a government or central bank that the currency is capable of being exchanged for its value in goods. A fiat currency is a national currency that is not pegged to the price of a commodity such as gold or silver. The value of fiat money is largely based on the public’s faith in the currency’s issuer, which is normally that country’s government or central bank. In contrast to commodity-based money like gold coins or paper bills redeemable for precious metals, fiat money is backed entirely by the full faith and trust in the government that issued it. One reason this has merit is that governments demand that you pay taxes in the fiat money it issues.

This fiat currency depreciated so rapidly that by 1776 it was returned to a silver standard. Fiat money also has other beginnings in 17th-century Europe, having been introduced by the Bank of Amsterdam in 1683. Government-issued fiat money banknotes were used first during the 11th century in China. Since President Richard Nixon’s decision to suspend US dollar convertibility to gold in 1971, a system of national fiat currencies has been used globally. The collapse of the fiat currency remains a highly improbable event, except in the case of higher inflation.

Commodity money is a medium exchange with intrinsic value due to its use for purposes other than money. Examples of this include gold like the one in Figure 1 and silver. There will always be a demand for gold as it can be used in jewelry, making computers, Olympic medals, etc. Furthermore, LTC gold is durable, which adds even more value to it.

Changes in public confidence in a government issuing fiat money may be enough to make the fiat currency worthless. When the State declares what kind of asset it accepts in payment of taxes, it assumes a liability equal to the outstanding stock of those assets. At the same time, the declaration creates financial claims on the State by the holders of the assets. The tokens may have a material value as in precious metal coins, or may simply be paper certificates with no intrinsic value.

  • The value of fiat money fluctuates due to factors such as government policy and the economy of the country.
  • For example, the US dollar, Euro, and INR act as fiat money that has no physical backing and is only affected by cross-currency valuations.
  • Before 1970, the world was governed by the gold standard, which allowed people to swap the currency they owned for gold at any time.
  • Any country that uses the gold standard buys and sells gold at a fixed price, and that price becomes the value of the country’s money.
  • Fiat money is easily accessible and accepted easily in various ways.

But Bitcoin has some of the same strengths and weaknesses as commodity and fiat money. It is only as valuable as people believe it is and has a finite value, such as a commodity. The next question remains, will Bitcoin become the future currency? The most important feature of fiat currency remains its stability, unlike commodity monies such as gold, silver, and copper. As mentioned earlier, the rise of fiat currencies came about as countries attempted to smooth out the business cycles and avoid the busts of credit cycles.

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